Wednesday, August 17, 2011

Regime uncertainty is a term coined by Robert Higgs to describe and ascribe what he believes to be the reason for the lacklustre US economy for the entire 30's and 40's. We now seem to be entering a similar period of uncertainty, and regardless of your opinion of what caused the Great Depression to remain that long, I would credit TODAY's regime uncertainty to a flawed understanding of the economic system by the leaders who shape the policies of the world. All around we see evidence of this flawed framework being put to test, with disastrous results. We need to advance discussion on a better understanding of the financial system, so governments do not enforce cures that only exacerbate the economic malaise, stimulate with measures that kill demand, or moderate bubbles with measures that feed it.

Income creation

I strongly believe the most urgent problem is lack of aggregate demand. What is the necessary cure? Income creation, which should come as a consequence of creating jobs that produce sellable goods. It is income which creates the demand for the goods being produced by the jobs created. So income should not come by itself as a handout. It should come as a byproduct of a labour force able to find joss when they are truly looking. Neither should jobs created provide insufficient income, or demand will not be sufficiently restored. Of course, each job created must also be productive to society, because income created without the commensurate increase in productivity only leads to a supply shock.

The question to ask is how does income keep on generating itself? All of us want to save in order to create wealth. Who then funds the saving? There should be a default spender of last resort, otherwise, when we all do this saving simultaneously, we all stop earning income from one another. And there should be aggregate confidence in the stability of markets, in the currency, and in the belief that income will continue. What makes this confidence possible? When the economy is backed by an employer of last resort able to issue its own currency. Now that national governments are out of the gold standard, they can print money as necessary to spend. Furthermore, taxation should not be the primary, or even the necessary, funding vehicle of this spending, as taxing people actually takes demand away from the private sector. When government takes money from the people, the people are again out of money.

The cure for the current problem is not austerity. The proper stimulus is not more debt at the household/business level, or a deliberate increase in price level via monetary easing. And asset bubbles are neither properly moderated with austerity measures or monetary easing.

Income creator of last resort

Before the age of industrialization and globalization, a great majority of people still lived off the land. Nobody really died of hunger if he didn't have a regular paying job. Just plant a potato in your backyard, and eat it. Now it's not the case anymore. Nobody has land large enough to cultivate the basic food he needs to feed his family, so he needs a job to earn the money to buy it. There are no more cases of homestead, everybody has to buy his abode, or otherwise rent it. To be able to do so, he needs to earn income.

There's no way for us to get back to the idyllic past of Lincoln's time, when losing income merely means people go back to bartering what they make, eating what they sow, and living on what they build. Now you have to buy everything! If a sufficiently large proportion of people loses their job during a market correction, they will stop buying goods not immediately needed for basic survival. This causes a cascade of further job losses as companies lay off their employees to cover the lost sales.

Nowadays, you need someone all powerful to provide everyone with the job and income to live a basic life - either an all powerful feudal lord, one who has monopoly control of all major factors of production, such that he has no fear of people withdrawing money/income from the system….

…..or a government that knows how to strike the right balance between creating income for the people via spending, and ensuring that the money has value enough to purchase an adequate supply of goods.

There are people who want more government, and those who want less. I think MMT, as a proponent of a way to understand monetary/income transmission throughout the economy, has no particular leaning as it is a purely technical description of how the monetary system currently works.

But I believe there's a time and place for more government, but you have to know what the purpose of expansion is. A valid purpose is helping restore full employment and aggregate demand when private sector initiative is lacking. For sure, we should also develop indicators to know when government should start scaling back, like when interest rates are already going through the roof or inflation is rising. The goal is to make it easier for private sector to start employing again, not to compete with them.

20 comments:

Warren Mosler recommends an immediate suspension of FICA, federally funded per capita block grants to states as long as needed, and an $8 hr/benefits federally funded ELR for anyone willing and able to work.

Rogue, I agree with much of what you write, but not this: "There should be a default spender of last resort, otherwise, when we all do this saving simultaneously, we all stop earning income from one another."

What you describe sounds to me like a rapid exponential curve to a valueless dollar. How about eliminating some of the tax advantages for saving, if you think excessive saving is creating problems? Or a wealth tax?

"Mosler's plan would really get the newly-created money directly to the users to spend."

But Mosler's plan does nothing to reduce excessive debt, which is the true root of the problem.

If the Federal Reserve printed money and used it specifically to pay off private debt created by fractional-reserve banking, the debt and the new money would both cease to exist. And people would recover their normal incomes. *This* is "a specific causal, transmission mechanism that increases effective demand directly."

I believe that Warren and the other MMT economists are substantially in agreement with you about debt as the underlying cause, Arthurian. What Mosler's plan does for the US, and his immediate proposals for Europe also, is treat the hemorrhaging. It's not meant as a fix for the underlying causes. See his proposals for financial reform for an approach to that.

Bill Black and Randy Wray claim that control fraud was and continues to be the actual cause, and the solution for that is enforcement of existing law and regulation. This has been difficult to impossible to carry out so far, due to the political clout of the financial sector, aka corruption and state capture. Bill Black has been documenting this for years, now, well before the beginning of crisis; yet, no meaningful action has been taken to date.

There is no doubt that until the overhang of private debt clears, the US will remains in the doldrums — if it avoids a debt-deflationary depression, the odds of which are increasing according to MMT economists like Wray.

Similar situation in Europe and UK, and Canada and Australia also have high levels of private debt due to RE. Same with China. So there is increasing risk of contagion resulting in global depression if there is a "Credit Anstalt" moment.

Arthurian, it's not so much that I believe in a valueless dollar, but if nobody is spending, and nobody is earning, all the money in the world will not do anything for anyone.

Printing money to extinguish debt seems like a good plan at first, but it doesn't take into consideration that a lot of the debt was incurred to finance non-productive endeavors, such as asset speculation.

In other words, this plan would be like printing money without increasing productive capacity. This would likely lead to inflation. It's so much better to print money in exchange for work which leads to productive capacity.

Plus, paying people for their debts is unfair. What would that tell people going forward? That it pays to get into debt? And what if people in the future get into debt in order to get ahead, i.e, bid up asset prices while trying to corner everything in the economy. In the end, you have people with assets and no debt, and people who never went into debt and don't have any assets.

This unfairness is what Hans is talking about in other comment threads.

Hi, Rogue. Let me discuss just one of your three points: inflation. You write:

"Printing money to extinguish debt seems like a good plan at first, but it doesn't take into consideration that a lot of the debt was incurred to finance non-productive endeavors, such as asset speculation. In other words, this plan would be like printing money without increasing productive capacity. This would likely lead to inflation."

And let me focus on just this part of that remark:

"In other words, this plan would be like printing money without increasing productive capacity. This would likely lead to inflation."

Printing money causes inflation. I get it. However, that principle does not apply to my plan. Bear with me a moment.

The threat that arises from deleverage is deflation, because the quantity of money falls as debt is repaid. I want to prevent this fall in the quantity of money that comes from deleverage. I do not want to print money and put it into circulation. I want to print money and DESTROY IT by using it to pay off debt.

There can be no threat of inflation from this newly-created money. The new money never goes into circulation.

It is true that repayment of debt does reduce the quantity of credit-in-use, and it increases the quantity of credit available for lending. If available credit is again put to use (in the form of new loans) this will increase the risk of inflation. But this is a different matter entirely, and I would point out that Fed policy of the last three years has been an *attempt* to have more credit put to use.

Again, I do not propose printing money to create inflation, as others do. I propose printing money to prevent the deflation that arises from the ordinary method of debt repayment. I propose doing this until debt is sufficiently reduced that the economy recovers.

Arthurian, ok, I see that your scenario causes the newly-printed money to be destroyed. It proves that there should be an element of debt writedown in solving the current mess.

But there should also be a rule that says people forgiven their debt should not turn around, and use their now increased net equity to again speculate on more assets. With their debt erased, they can now sell their assets and bid up on new assets, especially if NGDP proponents are listened to, and money is thrown to people to BORROW again. (If people don't borrow, how does NGDP grow constantly?) If this happens, we now have inflation, and we're right back to people with heavy debt.

It's also important for people to distinguish the difference between a more effective/efficient government and a nominally smaller government. The two are not the same. In fact a smaller government could very possibly be LESS efficient just as much as a larger government could be. It's about finding the "sweet spot." The Tea Party cannot comprehend such a concept. And we are closer to that sweet spot today than most realize. The biggest areas our government is over-extended is in the financial sector, the energy sector, and the campaign contributions department. Get those three alone in proper order and all the rest can really be tweaked on a more minimal basis. Those 3 are the big rocks to move.

@Arthur

"Again, I do not propose printing money to create inflation, as others do. I propose printing money to prevent the deflation that arises from the ordinary method of debt repayment. I propose doing this until debt is sufficiently reduced that the economy recovers."

yes exactly. Totally agree. Although printing money in and of itself does by definition create inflation. It's just that we need that now.

Your completely correct that if we were to slash FICA taxes for example (aka new money in the economy) then we'd likely see that money at least in part going to pay off debts, so theoretically consumption would not be altered. Except that is just not true. ;)

As more debts are properly paid off, trust comes back as does confidence and as does credit scores and economic metrics. Everyone in the world objectively starts to see a real recovery take place...that is HUGE and has a gigantic multiplier beyond measurement probably. Plus not all of that money would go to debts alone. Spending would greatly increase to be sure.

A balance sheet recession just takes time to process itself out for this very reason. That's why we better get started asap! There's only one way out of a hole and that's up. So getting out of our household debts is (in a sense) directly contributing to aggregate demand in a very healthy way. People actually being responsible with their finances is a good thing to be sure. And just imagine how the economy would be once the de-leveraging was completed and the FICA cuts and jobs program was still in place? Things would just move like gangbusters and then it's a matter of scaling back at some point to cool things down (however considering how indebted America is, how depressed housing is, and how wide our output gap is...I could see the cooling down phase not coming for years down the road). However it is something we all haven't exactly talked too much about...raising taxes is rather unlikely politically, so we would need to cut spending and that likely would work best b/c it's easier to do politically and it has higher multiples than tax cuts so that really works well at those times. ;)

The frustratingly funny thing about our current affairs is that our government is actually being VERY IRRESPONSIBLE when they all talk about the need for a "responsible" and balanced budget where the government "spends within its means." Wolves in sheep clothing to the nines!!!!

"By definition" I simply mean that any action that brings an economy closer to closing its own output gap and provides more private sector wealth is "inflationary." I don't think it's accurate to say it's a bookkeeping entry when individuals choose to put their own money wherever they want.

The QE 1 purchases seem to me to be more akin to a bookkeeping entry since they bought them at "mark to book" rates or what have you.

It only goes to show even more that MMT prescriptions are more than overdue in the USA. That is a full FICA tax cut and proper fiscal expenditure. B/c otherwise without that private debt accumulation AND no further federal deficits, then the standard of living in our nation is going to drop (as will GDP, employment, etc., etc.).

"It only goes to show even more that MMT prescriptions are more than overdue..."

Well I don't know about that, Mario. But I do not hesitate to adopt ideas that make sense to me, whether from MMT or anywhere. If MMT wants to adopt some Arthurian ideas, well, I'd see that as an improvement of MMT.

the blogs over at Warren Mosler's and Mike Norman Economics would be the places to check out. Tons of great discussions of all types of ideas and perspectives economic, political, etc. go on there. Check it out if you ever have the time. I'm sure people would gladly consider and respond to your ideas and questions for and against MMT and anything else economic.

Arthurian, I read your piece. I was most surprised that in 1970 the fed was targeting bank lending growth level. No consideration whatsoever about what the market needs or its credit worth. We can get really surprised at the kinds of control the fed will try to get away with without thinking of the consequences.

Search This Blog

"Conventional approaches, unconventional conclusions" on the global finance and economic issues of the day. Rogue Econ has been a banker and financial consultant in several countries. Welcome to my blog.